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The 2012 results from the Netherlands' five biggest pension funds out today underline how low interest rates are continuing to batter the sector and the role that risk-hedging swaps and bonds strategies play in keeping funds afloat.

Credit: Enric Martinez

Interest rates, and with them the yields on bonds and swaps, in the euro area continued to decline during 2012 – from 2.7% at the start of the year to 2.4% by its end. Pension funds use these rates to gauge their liabilities, and the lower the rate falls the larger their liabilities get.

The largest of the funds, the €281bn civil service plan ABP, reported a 96% funding ratio at the end of 2012, below the regulatory minimum of 105%. As a result it will have to cut pensions in April, it warned. The €47bn industrial workers' plan PMT, which is 92% funded, and its €32bn peer PME, which is 93.9% solvent, will also have to impose cuts on their members.

But the €129bn healthcare workers' plan PfZW has now recovered to a funding level of 101% and said no further cuts would be necessary. Managing director Peter Borgdorff said: "We are pleased about that".

The €31bn building-industry fund, BpfBOUW, reported a solvency ratio of 105.8% and said it, too, would not need any pensions cuts.

Interest rates, and the hedging of them, were the key driver governing the funds' solvency. All of them reported good investment results in 2012, ranging between 12% and 15%, but even these returns failed to keep up with their rising liabilities.

But the funds that made greater use of interest-rate hedges, using either bonds or swaps, did better. PfZW aims to hedge 40% of its liabilities in this way; BpfBOUW decided at the end of 2011 to increase its hedging to cover 60%.

ABP, by contrast, hedges only 25% of its liabilities. This morning a spokesman said the trustees had decided that with interest rates currently so low, it would be too expensive to buy cover right now – and if rates rise again, a fully-hedged pension fund would forego all the potential gains.

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This is also the thinking at PMT. Its policy is to hedge 35% of its interest-rate risk, because it has a relatively young membership. The fund has stated: "We explicitly choose this limited interest-rate cover under the long-term recovery plan, because with relatively young participants, we have a longer investment horizon" - that is, more time for its growth investments to come good.

Yesterday, the Danish public pension fund ATP reported a 9% return for 2012, with over three-quarters of that due to its interest-rate hedging. ATP's chief investment officer, Henrik Gade Jepsen, told Financial News yesterday that the fund "did not want to take the risk" of anything less than full interest-rate cover.

He said: "It is a perennial question, whether to reduce our hedges and profit from them. I have had this question for over 10 years, since we started hedging our rate risk in 2001. Then, long-dated interest-rates were 5.25% and people said they looked low.

"I was asked again 18 months ago, when rates were 3.5%, and people said they could only go up. They went down. Now rates are much, much lower. You can argue they will go up from here, and you might be right.

"For us as a pension fund, it is simply not worth the risk. For example, we have Dkr84bn of investment reserves right now [a surplus over the fund's liabilities]. If interest-rates fall by 1%, that would lose us Dkr100bn, wiping that out entirely."

Jepsen said that ATP does have views on where interest-rates are going, but it applies this in its return-seeking bond portfolio, rather than by altering its hedges.